Thursday, March 16, 2017

Cautious Optimism about Fed Independence

Unsurprisingly, the FOMC decided to raise its federal funds rate target by 25 basis points at its March 15 meeting. The move was widely anticipated, especially following the strong recent employment report. The day before the meeting, the New York Times wrote that the "Fed's challenge, after raising rates, may be existential," anticipating greater-than-ever threats to the Fed's independence from the President and Congress.

In the past few years, Republicans have been more frequent critics of low interest rates than Democrats. During the campaign, in September, Trump accused Yellen of keeping interest rates artificially low to boost support for Obama and the Democrats. However, a few months prior, in May, he expressed support for the Fed's low interest rate policy, primarily because of its favorable impact of the U.S. trade position with China and on government borrowing costs.

And since the election, it can again be presumed that he favors the maintenance of low rates. Why? For the same reason that most Presidents favor lower rates--to boost employment and growth (at least in the short run), and, in turn, Presidential approval. This is exactly why most central banks are granted independence: if Presidents set monetary policy, it would tend to be too loose, and therefore inflationary.

With Trump, this desire to boost employment and growth as a means to gain personal approval is especially acute. Trump is brazen in his desire to pass off job growth as a marker of his personal success:

So the worry reflected in the New York Times piece and elsewhere is that by raising rates, Yellen and the Fed are opposing the President's desires and risking retribution. The retribution could come in the form of legislation that would reduce the Fed's power or discretion, or in the form of Presidential appointments to the Board of Governors who would be more susceptible to Presidential persuasion. Trump will also have the opportunity to reappoint or replace Yellen as Chair next year. It seems, at first blush, that Federal Reserve independence is in serious danger.

While I don't want to undersell that danger, I do want to point out reasons to maintain at least a drop of optimism. First, fear of Presidential or Congressional retribution did not lead the FOMC to avoid this rate hike. Yellen is not willing to play by Trump's rules to ensure her reappointment. That was probably already obvious to anyone familiar with her career and reputation, but it is still noteworthy enough to reflect on. While the Fed's de jure independence is in tact for now, its de facto independence seems to be as well.

Second, with a President this polarizing and with approval ratings so low, Presidential attacks on the Fed could actually be just what the Fed needs. So far, Trump has avoided tweeting about the FOMC decision. But suppose Trump does criticize the Fed on Twitter soon. This might not be all bad-- it could be a case of "all press is good press." The biggest obstacle to the Fed's communication strategy, and in turn to accountability, seems to be its lack of a broad audience, and Trump--with 27 million twitter followers to the Fed's 402,000--could inadvertently provide the Fed with the communication platform it has so severely been lacking. The key will be for the Fed to use any newly-gained pulpit to convincingly argue why independence is worth protecting. This will be more effective if combined with discussions of how the Fed intends to hold itself more accountable to the public in the future.


  1. I think you are right about the unlikelihood of independence being seriously challenged in the sense of new legislation, or the appointment of Governors/Chair somehow loyal to the President that would take us back to the good old days when the Fed, especially its Chair, were mindful of the Administration’s wishes. But there is a third possibility which is to shift the composition of the Board and the FOMC in terms of various dimensions like background and overall view on monetary policy. This could have important implications for policy even though each member operated equally independently as now. According to my calculations (I could be wrong about something), Trump will have the possibility to appoint at least 4 members into the Board during this 4-year term alone including all the important ones: Chair, Vice-Chair, Bank Supervisor (with Tarullo leaving) and one more. And unless Yellen pulls a Marriner Eccles and stays on even after having been removed as chair, that would make it 5 members. So basically every decision that the Board makes would have Trump-majority and Trump-appointments would (probably) control agenda setting at the FOMC.

    Now suppose that these appointments would be either conservative economists or banker/business types. A couple of such people typically always exist amongst the FRB Presidents. This could imply that they might even hold a direct majority (or 6-6) in FOMC decision making at times. So the heavy emphasis on technocratic economists of various leanings that has dominated Fed decision making for a long time could be altered.

    Of course all this depends on who Republicans are willing to confirm to the Board and thus I don’t think that a huge shift is probable but on a smaller scale I think it will happen. And the result would be much less unity in the FOMC with unpredictable consequences.

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